Senator Eliot Shapleigh - El Paso, Texas

Texas is especially vulnerable. Nationally, college students get half of their financial aid dollars through loans. In Texas, it's closer to two-thirds. The rest of the money comes from grants.

For the cash-crunched, college-bound student, the loan pitches are seemingly everywhere – in the mail, on the Internet and on late-night cable TV. Borrow up to $40,000 a year for college. It's fast and easy to apply. Make no payments until after graduation. 

With college costs rising faster than federal aid and family paychecks, students in Texas and elsewhere are turning more to loans that are not subsidized or backed by the federal government. What the pitches for these so-called private or alternative loans often fail to mention, or bury in fine print, is that they almost always cost more than federally backed ones, with interest rates that can rival those of some credit cards.
 

While federal Stafford loans have a fixed 6.8 percent interest rate, private loan rates can run as high as 20 percent and can vary over the life of the loan.

Texas is especially vulnerable. Nationally, college students get half of their financial aid dollars through loans. In Texas, it's closer to two-thirds. The rest of the money comes from grants.

Allison White, a sophomore at Southern Methodist University, received several thousand dollars in grants and federal loans. But it still wasn't enough to cover her $42,000-a-year sticker price at SMU. So far, she's borrowed almost $27,000 in private loans from College Loan Corp.

Ms. White said she's glad to have the loan – she needed it. Still, she said she's concerned that students need to learn a lot more about private loans and how to shop for them.

"I think the commercials just make it seem too easy – 'Here, take this money and you can pay it back four years later.' But they fail to tell you they're charging interest while you're in school," she said.

Some lawmakers and consumer advocates are pushing for tighter regulation of private loans. They want banks to disclose more details about the terms of the loans, to limit interest rates and to stop marketing practices that some consider deceptive.

"It's not that private loans don't have a right to exist. It's that they should be the loans of absolute last resort," said Lauren Asher, associate director of the nonprofit Project on Student Debt, which studies college loans and their effects on students, families and the economy. Private loans, she said, have highly variable terms, are difficult to compare and lack certain consumer protections.

Banks and companies that give private student loans say their products fill a growing need.

"The problem is that college costs – tuition, room and board – have gone up faster than overall inflation and families' incomes," said Tom Kelly, a spokesman for Chase Bank. "To pay for college, people need to fill that gap, and private student loans are one of the solutions."

Mr. Kelly said Chase makes terms clear so that before students sign for a loan, they know what rate they're getting. "We try to be a responsible lender whether we're making mortgages or student loans," he said.

The most popular student loans are subsidized and insured by the federal government – think Stafford and ParentPLUS loans. But private loans are increasingly common. They account for an estimated 27 percent of all undergraduate borrowing, according to the College Board. That's up from 5 percent a decade ago.

The College Board surveyed lenders to estimate private loan volume. Similar numbers aren't available for Texas, because many private loans are given directly to students, without colleges ever knowing.

But Texas financial aid officials say that the use of private loans they do know about is rising.

"Ten years ago, you just didn't have them. Today, we have about $12 million worth," said Joe Pettibon, financial aid director at Texas A&M University.

SMU has seen a 10 percent to 15 percent increase in private loan borrowing over the last three years, financial aid director Marc Peterson said.

"Whereas there were very few private loan products for undergraduate students, more and more companies are entering that marketplace," he said. "They're filling a need, obviously, with a deficiency in other aid."

Financial aid experts see several reasons for the growth of private loans. The biggest: College costs keep growing faster than inflation and average family incomes.

In Texas, the average total sticker price is $17,000 a year at public four-year universities and $26,000 a year at private ones. Tuition at Texas public universities has increased 40 percent, on average, since 2003 as the Legislature has allowed state funding per student to drop and authorized campuses to make up for the shortfall by setting their own tuition.

Meanwhile, government loans and grants aren't keeping pace, so they cover less and less of total college costs. Experts say the growing gap reflects in large part the decision of federal and state governments not to increase aid more substantially.

For instance, federal Pell grants for the poorest students are capped at $4,310 this year and cover only about a third of the average cost of tuition, room, board and fees at a public university, down from about half 20 years ago. With federal Stafford loans, which have a fixed 6.8 percent interest rate, most undergraduates can borrow a maximum of $3,500 to $5,500 a year.

Recent changes in federal law have cut the guaranteed profit that lenders make on federal loans. Some experts say that's made private loans more appealing to lenders because they can set their own rates.

New York Attorney General Andrew Cuomo has called private loans "the Wild West" of the student loan industry because they're much less regulated and harder to compare than federal loans.

Unlike federal Stafford loans, which are based on financial need, private loans are typically based on the borrower's or co-signer's credit history. Sometimes, lenders charge higher interest rates to lower-income students – which runs counter to the philosophy of sending needy students to college, Sen. Chris Dodd, D-Conn., testified last year. Some lenders, including giant Sallie Mae, also give rates based on the school a student attends.

Consumer advocates say it's hard to compare loans. The interest rates that lenders list online, for instance, are often for the most credit-worthy borrowers. Students don't learn the rate they'll get until they apply.

There are also complaints about how private loans are marketed.

Stephanie Njoku, a student at the University of Texas at Dallas, said she's seen the late-night TV ads promising loans of up to $40,000 a year and only minutes to apply.

"Most kids aren't going to think reasonably about the money they're spending," Ms. Njoku said, "and they're going to blow it."

Private lenders say they have to charge more because they face a greater risk. If a student defaults on a federal loan, the government covers most of the bank's loss. That's not the case with private loans.

Lenders say they make the necessary disclosures.

"We're very clear that these are not federally insured loans. We say to students, 'Look at your other alternatives,' " said Mr. Kelly, the Chase spokesman.

One Chase letter sent to students notes, "With rising tuition costs, federal student loans and scholarships can only go so far."

As for complaints about the mailings sent to high school and college students, Mr. Kelly responded, "Tell me how it's a problem to let people know about opportunities."

A Web site of one brand of private loan, Astrive, makes a pitch common in the industry. In big letters it says: "Borrow $1,500 to $40,000 per year." Below that in smaller letters, it says: "When grants, scholarships, and federal funding don't cover all your college costs, an Astrive Student Loan can help fill in the gaps."

On another page, Astrive says its annual percentage rates are as low as 9.1 percent. But the fine print notes that they can run as high as 15.1 percent and that rates could change.

"Our main principle is that people should take advantage of all the federal and free aid they can first, before taking out private loans," said Janice Walker, a spokeswoman for First Marblehead, the company that markets loans under the Astrive brand, among others.

First Marblehead also created a Web site, smartborrowing.org, to educate student borrowers. One of the subjects on the site is called "Federal Aid First."

Congress is considering legislation that would require lenders to notify colleges if students want to borrow $1,000 or more in private loans, and it would require certain disclosures throughout the loan application process. Students also would have 30 days to consider an offer, and, if they accept it, three days to cancel.

Some schools are taking their own steps. Since 2006, Barnard College in New York has required families seeking private loans to first talk with a financial aid counselor. A year after the change, the private loan volume plummeted from nearly $1.6 million to $415,000. Aid officials at the women's college said they believe the conversations made families more aware of risks with private loans, and their other borrowing options.

Texas A&M's advice to families: "A private loan should be your last resort," Mr. Pettibon said.

Texas A&M will contact families if a request for private loan certification comes through and the family hasn't applied for financial aid.

SMU lists six private lenders for undergraduates on its site, but it advises students to "always use Federal loan options if you can" before going the private route.

Financial aid officers say with private loans, it's especially important to shop around and compare rates – and not to just decide based on something in the mail or on TV.

Ms. White, the SMU sophomore who borrowed almost $27,000 in private loans, said she received a decent interest rate, as private loans go – 7.75 percent – and she's glad to have the money.

But she knows she'll be paying it back when she graduates: "It kind of scares me that I'm only in my second year of college and I already owe over $25,000."

Here's an idea of how much more a private loan could cost than a federal one. In each case, the borrower takes out $20,000 and will repay it over 10 years. Federal Stafford loans have a fixed 6.8 percent interest rate, while rates for private loans vary considerably and may change over the life of a loan. This example assumes a rate of 12 percent. (Note: These figures do not include any origination fees or other charges that may be added to a federal or private loan. For a more detailed comparison, contact your local college financial aid office.)

Federal Stafford loan

Loan amount: $20,000

Interest rate: 6.8 percent

Monthly loan payment: $230.16

Cumulative payments: $27,619.31

Total interest over life of loan: $7,619.31

It's estimated that you would need an annual salary of at least $27,619 to afford this loan (based on 10 percent of gross monthly income going to the loan repayment).

Private loan

Loan amount: $20,000

Interest rate: 12 percent

Monthly loan payment: $286.94

Cumulative payments: $34,433.24

Total interest over life of loan: $14,433.24

It's estimated that you would need an annual salary of at least $34,433 to afford this loan (based on 10 percent of gross monthly income going to repay the loan).

SOURCE: www.finaid.org